Importance of Credit Management

Importance of Credit Management

Granting credit is one thing and collection another. Thus, there is a need for a system which will ensure close collaboration between the grant of credit and its collections. While it is true that selling goods and rendition of services only to customers who have shown and demonstrated their willingness and ability to pay on the basis of their past records would doubtlessly reduce the incidence of risks, nevertheless, such policy will evidently result in a reduction in the sales volume and ultimately work adversely against the interest of the firm.

On the other hand, precipitous and indiscriminate granting of credit to all types of customers, while increasing sales volume, could undermine a firm and usher its collapse. Hence, the need as well as the importance of a sound and efficient credit management.

The Credit man in the business World

Today, there is a recognition of the important contribution of the credit man to he successful operation of the company.

Failure on his part to discharge properly the task and responsibility reposed upon him by virtue of his position in the company could adversely affect the business world in general. Lack of judicious care in the grant of credit will not only trigger losses in a diminution of credit to those who are deserving and are actually entitled to it.

On the other hand, the overzealousness of the credit man to prevent losses for the company and thus become overly strict with respect to the grant of credit could generate the loss of customers and thus consequent reduction in the volume of the business.

The Credit Department

Its task and responsibility revolve around the gathering of all credit information about the applicant and assembling them in such a way that they could be of help in properly guiding the loan officers in their assessment and analysis for purposes of establishing correct credit rating. In a number of instances, one overriding factor which the credit department must give weighty consideration is, not only with respect to the degree of profitability to be derived from the credit operation, but also its influence as a booster in the sale of other goods of the company.

In the case of banks, the credit department collects and files every available bit of information concerning people or firms that borrow money.

In a detailed manner, its main work consists of:

Investigating

Assembling

Analyzing

Recording credit information

The Credit manager

He occupies a very important position in the structure of a credit economy and yet is little known and least talked about outside the world in which he lives. Upon his decision rests the success or failure of a credit-granting organization. In small concerns, he is the credit investigator, credit appraiser, credit supervisor, and credit manager all rolled into one.

He is the head of a staff trained, experienced and capable men charged with credit work. A good credit manager is progressive in his ideas and thinking. Moreover, he should be devoid of prejudices against and biases in favor of any man or organization. Otherwise his thoughts and views will be colored by them. He should be morally upright and intellectually honest and must have a complete knowledge of the facts surrounding every application for credit, if he is to discharge his responsibilities well.Credit Investigation

The task is performed by the banks credit investigator who has, as his main objective, the verification as well as evaluation of the applicants character, credit standing and integrity throughout the process of data gathering of all essential facts. Generally speaking, the elaborateness of a credit investigation as a practical matter depends upon its cost relative to the magnitude of the principal and interest involved and the security being offered by the applicant. The results obtained from credit investigation is an essential part of credit analysis for the proper evaluation of credit risks which necessarily can not be any better than the facts assembled.

The request for Credit Investigation Report (CIR) may come from the any department of the bank for any of the following purposes:

Clients seeking loan accommodations or credit line with the Loan Administration Department through Marketing Management Department

Clients applying with the International Banking Department to secure availment in the form of Letters of Credit, Import/Export Bills, Trust Receipts and other forms of accommodations

On clients transferring business with the Treasury Department through the monetary desk

On co-makers and guarantors for credit

On old clients for updating client information

On insurance companies requesting accreditation or offering to act as surety

On beneficiaries named in the Letter of Credit

On prospective buyers of assets acquired by the bank

On prospective suppliers of office equipment and supplies and contractors of services

Scope of Credit Investigation

Purposes and Types of Investigation. Whether the investigation is a routine matter or a special case and the purpose is general or specific

Company Credit Policy. Whether the policy is a conservative or liberal one, and whether it requires a comprehensive investigation of cases, or a representative sampling would suffice

Client Classification. Whether the client is new or an established one

Amount Involved. Whether the amount involved is big or small. If it is a small one, chances are a limited type of investigation will suffice. If it involves a fairly large sum, investigation may be rigid and thorough relative to the risks involved and with respect to the amount of income to be derived measure of profitability.

Time and Resource Constraint. The scope depends on such factors since the report must be finished on the date it is needed by the requesting officer/department of the bank and also, on the availability of the credit investigator who will conduct the investigation.

I Companys Background/history

a) Single Proprietorship. The credit investigator sees to it that the owner has the capacity to enter into a lawful contract. If the owner is a married woman, she must possess the legal right to transact business as required by the Civil Code of the Philippines

b) Partnership. The first fact to be determined is whether the partnership is a limited or general one. This is important and essential since under a general partnership, all the members are general partners, As such, they are liable to the extent of their personal properties, either pro-rata or solidarily for partnership debts. In a limited partnership, on or more members, aside from the general partners, are limited partners who as such shall not be bound by the obligations of the partnership.

Second whether the contract of partnership is registered with the Securities and Exchange Commission is not a pre-requisite for the acquisition of juridical personality of a partnership since the juridical personality begins from the moment of the perfection of the contract.

The credit investigator shall look into the following characteristics of a partnership:

There must be a contract

The partners must have legal capacity to enter into contract

There must be a mutual contribution of money, property or industry into a common fund

The purpose to obtain profits and distribute the same to its members

The purpose of the partnership must be lawful

c) Corporation. The legal existence of a corporation beigns from the date of the issuance of the certificate of incorporation by the Securities and Exchange Commission.

Important matters which a credit investigator should carefully consider in the Articles of Incorporation are the following:

Name of the Corporation

The purpose, objective, nature and powers

Location of the business

Term of duration of corporate existence

Names and residences of the incorporators

Names of incorporating officers

The capital stock and the number of shares into which it is divided

Names and citizenship of stockholders and the amount or number of shares they have subscribed to and the amount paid on subscriptions

The acknowledgment of the duly executed Articles of Incorporation before a notary public

II Financial Conditions

Herein is represented the balance sheets and income statements for the past three to five years. It may include schedules, explanations or extraordinary items, breakdown of merchandise and receivables and full explanations of all inter-company loans and merchandise transactions.

III Dealing with Government Lending Agencies

a) The CI concentrates on the size and degree of fluctuations on borrowings as well as the nature of the security pledged to secure the loan. In case of long-term loans, the yearly, semi-annual, quarterly or monthly installment payments to maturity must also be obtained.

b) A multitude of facts that could be obtained from merchandise suppliers. They may be useful in matters pertaining to incidence of credit, amount owing, amount past due, if any; terms and payment performance of the subject of inquiry.

IV Banks experience with the subject

V Court Cases

The following information must be sought:

a)The importance of the subject in its particular line of business, the general reputation, the ability of the management and the quality of the products and or services being offered.

b) The general outlook as to the conditions in the subjects line of business and whether the operating methods used are considered sound

c) Whether the subject resorts to unfair method of competition

Formulation of Bank Loan Policy

Any loan policy that may be formulated by a bank reflects but one phase of the over-all policy program of the institution. Such a policy must obtain the stamp of the board of directors. The preparation of the policy is usually carried out by the president or senior loans and credit officer, depending in large measure upon the size of the bank and staff available.

A statement of loan policy including reference to the types of loans and the basis upon which the loan applications may be considered. Also, the kinds of securities that are considered acceptable by the credit-granting institution are also subject of the loan policy.

Briefly noted in the formulation of a loan policy, the officers are guided by two considerations: First, the protection of the depositors funds. Second, the production of a fair return for its lending and investment activities, The activities of the credit department contribute a major portion of a banks income.

Setting a Standard for Control PurposesIt goes without saying that no policy achieves maximum effectiveness unless it is accompanied by a periodic check-up to insure its proper implementation and ascertain its weak spots, if any. In fact, by having an established loan policy, a program is made possible against which actual performance of practices can be evaluated for purposes of determining variations, and the necessary application of remedial action. A sound loan policy should be made flexible to provide for alternative courses of action and thus enjoy the advantage of the policy serving as a guideline.

The loan policy should provide specific guidelines for particular types of categories of bank credits, such as the following;

Agricultural credit

Commercial Loans

Industrial Loans

Real Estate Loans

Consumer/ Personal Loans

Term Loans

Credit File

The credit file s important to any firm extending credit so that it behooves upon it to adopt a system of gathering and putting information about customers and applicants into a folder which is filed in proper order.

As credit information is received by the credit man, he goes over it to carefully make sure it is as complete as possible. Then he puts it into a credit folder bearing the customers name and address.

Maintenance of credit files with utmost confidentiality should be the over-riding concern of the official charged with this responsibility. Because of the confidential nature of the information contained in the credit files, folders can only be withdrawn upon prior authority granted by the responsible official.

Credit files give historical a transactions and are generally observed subdivided into a number of sections. For instance, the first section is used for statements. As may thus be logical to expect, the latest financial statement of the company is found with the banks comparative statement form. The second section contains a compilation of reports on interviews conducted by the loaning officer of the bank and his staff. Correspondence and other related matters with banks and business firms are contained in the third section. The fourth section contains an up to date file record of borrowers as well as prospective ones. The fifth section contains reports from credit agencies whose services and assistance have been sought by the bank.Scope of Credit Policies of Commercial Houses

Credit Terms is the terms or conditions under which the credit is granted. It includes the time when payments must be made and the discounts that will be allowed for prompt payment.

Credit Period means the length of time within which the customer is expected to remit in part or in full. If the period expires before such payment has been made, the account becomes delinquent.

Credit Limit is the limit with respect to the amount or value that a customer can obtain from the firm.

Purpose and Advantage of Credit Limits

The principal purpose of credit limits is to serve as guides to credit management and control. In fact, through its use, before the determination of credits, there is he need for careful investigation and comprehensive analysis of the elements composing a given risk. This is conducive to credit granting.

It is evident that credit limits operate as an overall device for the control of credit extensions. More specifically, credit limits aid in reducing the cost of credit management and in enhancing its efficiency. Limits also work to the advantage of debtors. It serves as a check against reckless buying spree of which if unchecked could ruin the lives of debtors and as such suffer the disgrace of being labeled as poor debtors.

Principles of Controlled Credit

Only after a thorough investigation of the credit worthiness of the customer seeking credit may credit can be granted

Each new customer should be made acquainted with the terms and conditions as promulgated and implemented by the business firm with respect to terms of payment; discounts, credit period and credit limit

It is necessary that the first reminder be sent immediately, the next day after bills become past due

Continued use of the credit privilege should be suspended in respect to slow-paying customers

Decisions and actions should be characterized by firmness but short of being rude and arrogant

When it becomes absolutely necessary, the services of collection agencies must be sought or legal services enlisted as the case may be

Granting Credit

Three major considerations immediately come into the picture all of which merit attention.

The first relates to the size of the order. Not infrequently, a number of business firms may be willing to take certain risk, that it readily allow a small first order without a thorough and complete credit checking than they will in the case of large order.

The second refers to the indentity of the applicant for credit and his reference. The business firm should be sure of the reputation and integrity of the applicant as well as the references which accompany the other.

Third is the customers rating appears in the register of some mercantile agencies. This is not always possible especially so when the customer is new in the business and therefore has not yet established a name or reputation for himself.

Sound Credit Management

Sound credit management principles revolve around three Es

Estimation:

All available sources of credit information must be tapped and utilized so that a proper estimation of the credit risk can be obtained

For individuals who buy for consumption, character and their ability to pay serve as important bases of credit, for business concerns, it is the net worth and condition of the business as well as reputation for paying their bills

All credit information gathered and received must be kept in strict confidence. Only those who are authorized must have access to it.

Enforcement:

Granting credit is but one phase of the credit function, collection is another. Collection of accounts should start from the moment they become due.

The task and responsibility o very collection department is to get the money due the company. If the money can be collected without offending the customer, this should be done

Collection records must be kept and maintained and should indicate notices were sent, dates when calls were made by collectors, payments made and balances due.

Evaluation

Sound credit management principles dictate that results must be valuated against company policies and procedures

If a situation should arise in the future which preclude good-paying customers to discharge their obligations on time, policies and procedures maybe modified without losing sight of company goals and objectives

Records should be periodically reviewed and kept up to date